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China’s Dual-Track Challenge

HONG KONG – With China's economic slowdown more apparent than ever, its prospects of avoiding a hard landing are weakening. Whether policymakers succeed will depend on whether they can navigate the challenges stemming from an increasingly divided dual-track economy.

The latest year-on-year data, from January, highlight the danger. The consumer price index dropped to 0.8%; the producer price index fell by 4.3%; exports contracted by 3.3%; imports were down by 19.9%; and growth of broad money (M2) slowed by 1.4%.

Moreover, the renminbi has come under downward pressure, owing partly to economic recovery in the United States, which has fueled capital outflows. Given huge declines in industrial profit growth (from 12.2% in 2013 to 3.3% last year) and in local-government revenues from land sales (which fell by 37% in 2014), there is considerable anxiety that today's deflationary cycle could trigger corporate and local-government debt crises.

China hopes to secure its long-term economic development by shifting from a state-directed to a market-led economy. But the process has created significant discrepancies in economic performance, with state-owned enterprises (SOEs) performing significantly worse than their private-sector counterparts, despite having better access to credit. And there is a widening disparity between real-estate prices in China's thriving first- and second-tier cities and its lagging third- and fourth-tier cities (though higher household incomes in the former make housing there more affordable).